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IMF urges sovereign bond changes after Argentina case

Tuesday, October 7, 2014 - 06:55

[WASHINGTON] The International Monetary Fund on Monday urged changes in sovereign bond contracts as Argentina remained mired in a US court battle with "vulture funds" years after its massive debt restructuring.

The IMF said standard clauses in bond contracts between governments and their creditors need recasting and strengthening to make restructurings go smoothly after a country defaults.

Specifically, changes could avoid a situation like Argentina's where a minority of "holdout" creditors could upset a restructuring by refusing to join and seeking full repayment.

The New York court's 2012 ruling in favor of the Argentine holdouts, the IMF said, established "potentially far reaching" interpretations of bond contract clauses that could affect other sovereign bond issues.

With the IMF often deeply involved in rescuing a country after it defaults, it has a deep interest in ensuring that such restructurings - like that of Greece's 206 billion euros (US$258 billion) in borrowings in 2012 - work out.

"If future courts interpret the New York court decisions broadly, there is a significant risk that the sovereign debt restructuring process will become more complicated," said the IMF.

In Argentina's case, two US hedge funds scooped up bonds cheaply after the country defaulted on almost US$100 billion in debt in 2001 and then refused to go along with subsequent debt restructurings in 2005 and 2010.

The restructurings were supported by about 93 per cent of creditors, who agreed to take losses of up to 70 per cent on the face value of their bonds to help Buenos Aires stabilise its finances.

But the hedge funds sought 100 per cent payment on the US$1.3 billion face value of their bonds, and sued Buenos Aires in the US court with jurisdiction over the bond contracts.

Based on certain clauses in their bond contracts, the court backed the holdouts' claims and ordered Buenos Aires to pay them.

But that potentially threw the viability of the restructurings into question, because it eroded the incentive to support them.

The IMF report said that the standard "pari passu" or "equal treatment" clause in the Argentine bond contracts permitted the holdouts to make their claim for 100 per cent.

In future bond deals, the IMF said the pari passu clause should be changed "in a manner that ensures that the type of remedy provided to holdout creditors in the case of Argentina would not be replicated in future cases." Likewise, it urged the strengthening of "collective action clauses" by which the majority of a country's creditors can decide on a restructuring without leaving room for holdouts to undermine it.

That includes making sure that all series of a country's bond issues join a single restructuring vote, rather than holding separate votes by series, the IMF proposed.

"The possibility that holdout creditors may obtain a blocking position in a particular bond series may, for inter-creditor equity reasons, undermine the incentive of holders of other series to agree to the terms of the restructuring," the IMF said. - AFP